Executive compensation can have a major effect on overall organization performance in banks and other financial institutions. Unfortunately, it also can serve as a lightning rod for complaints, concerns, and discontent among the main stakeholders including boards, regulators, and employees.
The scrutiny that executive compensation normally attracts has been intensified in recent years. This added pressure came about partly as a result of growing media attention to executive pay, but it also is a necessary response to new and pending regulatory disclosure requirements.
With the increased focus that executive compensation now receives, financial institutions can benefit from a careful review of current compensation policies and practices. This article will offer an overview of some of the most widely used forms of executive compensation, current compensation trends in financial services organizations, and what institutions should be considering to prepare for the increasingly detailed disclosure requirements that are on the horizon.
Executive Compensation Overview
In order to discuss executive compensation trends with clarity, it is important to begin with a clear understanding of the terminology, as well as the most common forms of executive compensation. In most cases, of course, the largest portion of a bank executive’s compensation is base salary, a relatively straightforward measure that is fairly simple to track and compare. The other common form of compensation an annual cash bonus.
Above base salary and bonus, however, banks offer executives various types of long-term compensation, which complicates the picture and makes tracking and analyzing compensation practices more difficult. These long-term compensation tools can be organized into two major groups.
1. Equity-based compensation. This group can be further divided into two subcategories:
- Appreciation awards. These provide value only if the organization’s stock price increases. They generally are used as direct performance incentives. Examples include incentive stock options, nonqualified stock options, and stock appreciation rights.
- Full-value awards. These provide value even if the stock price remains flat or declines. Full-value awards can serve as retention tools or performance tools depending on the vesting provisions that are used. Examples include restricted stock, restricted stock units, and phantom stock.
2. Nonequity-based deferred compensation. This type of compensation generally provides for payment only upon the occurrence of certain events such as retirement or separation from the institution, death, disability, or other future events. Nonequity-based deferred compensation also can be further divided into two subcategories:
- Defined contribution. These programs often involve a set formula for the amount contributed by the employer (but they also can be completely discretionary) and are more easily tied to performance.
- Defined benefit. These programs involve a set formula for the amount paid to the employee and generally are more focused on retention.
Current Trends in Executive Compensation
Every year, Crowe surveys financial institutions throughout the United States about compensation trends, benefits, incentives, and other human resource issues. The 2015 Crowe Financial Institutions Compensation Survey drew responses from 296 financial institutions of all sizes, providing salary benchmarks for more than 230 different job positions.
Over time, the relative compensation of various job positions grows and recedes, reflecting changing trends in the financial institutions industry and the overall economy. At an even more elemental level, these trends provide a clear demonstration of the law of supply and demand.
For example, comparing the 2015 results with those of previous years offers some revealing information. In looking at the changes in average executive salaries and bonuses that can be observed over the past one- and five-year periods, we can begin to discern how institutions were strategically responding to issues over the course of the recession.
As Exhibit 1 illustrates, the demand for CFO talent continued to grow steadily throughout the recession and recovery. This was a notable contrast to other positions that had “ups and downs” that correlated to the then-current economic concerns.
Exhibit 1: Executive Cash Compensation Trends
|Position||Average Salary – 2015
||Salary Change (1 Year)
||Salary Change (5 Years)
||Average Salary and Bonus – 2015
||Change (1 Year)
||Change (5 Years)|
|Chief Executive Officer||$253,329||-2.00%||10.14%||$301,557||0.13%||19.80%|
|Chief Financial Officer||$173,355||9.22%||26.84%||$194,542||7.51%||31.28%|
|Chief Lending Officer||$153,318||0.02%||13.16%||$172,422||1.71%||17.55%|
|Chief Credit Officer||$149,678||-4.65%||16.87%||$162,187||-6.68%||21.01%|
|Top Trust/Wealth Manager||$136,058||10.32%||9.60%||$159,488||9.07%||19.82%|
|Top Retail Banking Manager||$123,533||3.04%||1.35%||$132,056||-1.19%||1.51%|
|Chief Information Officer||$115,042||5.27%||9.55%||$122,742||4.89%||11.52%|
|Chief HR Officer||$103,341||-0.09%||22.64%||$111,890||0.21%||27.53%|
The trends in cash compensation also reflect deeper, ongoing industry trends, particularly the decreasing value of retail banking as part of the overall operation of many institutions. The average salary for a top retail banking manager has been relatively flat over the past five years, and when both salary and bonuses are considered, the average total cash compensation package for a retail banking manager actually declined in the past year.
Chief lending officers and chief credit officers also have weathered fluctuations in both base salaries and total cash compensation. The higher demand for their expertise during the depths of the recession can be seen in the sizable boosts they have enjoyed compared with just five years ago, yet the demand for their capabilities has declined measurably over the past year as banks’ strategic priorities began shifting in the post-recovery period.
Incentive Compensation Practices
In addition to general trends in executive compensation, the Crowe Financial Institutions Compensation Survey also provides insight into what types of performance incentives commonly are used in financial institutions and how banks go about managing their executive incentive programs.
For example, both research and industry experience demonstrate that annual discretionary bonus plans are less effective in motivating performance than plans that are tied more directly to key performance metrics. Nevertheless, annual discretionary bonus plans were the most common performance incentive in the 2015 survey, with 42 percent of all banks reporting they used such a plan. A smaller number (32 percent) reported that they used comprehensive incentive plans tied to specific performance metrics.
For those institutions, overall profit and growth in both revenue and asset balances remain the most widely used factors in determining incentive compensation, as shown in Exhibit 2.
Exhibit 2: Factors Used to Determine Incentive Compensation
Source: 2015 Crowe Financial Institutions Compensation Survey
The survey also confirms that board oversight is important to effective incentive plans. Almost half (47 percent) of banks in the survey reported that their board compensation committees review and approve plans annually.
In terms of long-term and equity compensation packages, 42 percent of the banks surveyed offered some type of nonqualified retirement plan. Equity-based plans were offered by 30 percent of the participants, with stock options being the most widely used of such incentives.
Changing Compensation Disclosure Rules
The ability to compare a financial institution’s compensation practices to those of its industry peers always has been valuable as a strategic planning and management tool. More and more, however, this type of comparison also is being mandated by regulatory agencies, as they implement increasingly detailed executive compensation disclosure requirements.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) implemented a number of new requirements related to executive compensation including mandatory clawbacks of unearned compensation, transparency of incentive compensation agreements, and shareholder “say-on-pay” advisory votes. Two major new disclosure requirements now are on the horizon for publicly traded financial institutions and are scheduled to be enforced by the Securities and Exchange Commission (SEC):
- Pay-for-performance. The Dodd-Frank pay-for-performance disclosure rule is intended to require that publicly traded companies disclose the relationship between the compensation that is paid to executives and the actual financial performance of the organization. The regulations still are pending but are expected to be finalized by the end of 2015, with the disclosure requirement expected to go into effect for the fiscal year beginning on or after Jan. 1, 2017.
Under the expected rules, publicly traded financial institutions will be required to provide a clear description of the relationship between executive pay for named executive officers (generally C-level executives) and the cumulative total shareholder return (TSR), which includes both dividends and changes in share price. In addition, publicly traded banks with more than $5 million in total assets also will be required to compare their cumulative TSR to that of a chosen peer group and must provide this information for the five most recent fiscal years on their annual proxy statements.
- Pay ratio. New pay ratio disclosure regulations already have been finalized, and banks will be required to be in compliance by the fiscal year beginning on or after Jan. 1, 2017. These regulations require banks to compare the total compensation paid to the principal executive officer (typically the CEO) with the median total compensation paid to all other employees. The final comparison must be reported as a ratio.
Smaller reporting companies – those with a public float of less than $75 million or annual revenues of less than $50 million – are exempt from this requirement. All other banks, however, should be taking steps now to plan the most effective way of communicating this information in compliance with the SEC rules.
The Critical Role of Executive Compensation
Executive compensation always has had a powerful influence on financial institution performance. In today’s environment, however, it is also an issue that must be considered in light of its significant compliance and regulatory aspects. Moreover, while the stated purpose of the new executive compensation disclosure requirements is to provide shareholders with more information for making investment and voting decisions, these disclosures could have a significant impact on employee morale and productivity.
Ultimately, regulatory compliance as well as employee motivation and improved organization performance all depend on having access to accurate, up-to-date information – both about the institution’s own compensation policies and about current industry practices. With the continually increasing attention that executive compensation now receives, financial institutions must actively monitor, measure, and manage their compensation policies and practices.